Yahoo-MySpace: A Microsoft Alternative, But A Bad Deal

Now that Yahoo! and News Corp are discussing a MySpace+Cash for
Equity swap, it's time to analyze this idea. Would it be a
Microsoft alternative? Would it be smart? Is it likely to happen?
Yes, no, and no.

Unlike outsourcing-search-to-Google or merging-with-AOL,
the MySpace deal would be a viable alternative to a Microsoft
takeover. If Yahoo sold its stock at a high enough price
(and bought MySpace at a low enough one), Yahoo shareholders
might be persuaded that the MySpace combination would eventually
produce more value for shareholders than a sale to Microsoft.

Yahoo buying MySpace at a $6 to $10 billion valuation
would be a bad idea. (For Yahoo. It would be a GREAT idea for
News Corp) Unless Yahoo sold its own stock at an
exceptional price, therefore (in exchange for the cash portion of
the swap), Yahoo would likely be paying too much for a troubled,
stalling asset that has already proven hard to monetize.

A News Corp-Yahoo deal is not likely to happen for the
same reason that another non-Microsoft competitive bid for Yahoo
is not likely to happen: Because Microsoft won't let it.
The News Corp-Yahoo discussions have most likely been undertaken
to create an alternative to a Microsoft deal--and, thus, force
Microsoft's bid up--rather than because Jerry or co think they'll
really come to fruition.

Yahoo would emerge larger and better capitalized, with a strong
position in social networking--an area in which it is currently
weak. It would remain a stand-alone public company, which we
think is a big advantage versus the Microsoft deal (stock
options, more manageable size, less inter-division bureaucracy,
etc). Lastly, it would have a lot more ad inventory (albeit of
questionable value).These are fine positives. Unfortunately,
they're outweighed by the negatives.
Negatives of a MySpace-Yahoo Combo

MySpace has long since lost its momentum to Facebook,
which will
soon eclipse MySpace's traffic on a global basis.
MySpace's competitive position is similar to Yahoo's four or five
years ago: industry-leader, but less innovative, slower growing,
and ultimately less competitive than its upstart competitor.
MySpace is to Facebook, in other words, as Yahoo was to Google.
Putting the two weaker companies together won't help them get
more competitive.

MySpace has proven hard to monetize. Even Google
can't figure out how to do it. MySpace's financial performance is
heavily dependent on a deal that may be renewed on far worse
terms within two years.

MySpace's DNA is rooted the Los Angeles entertainment
industry, not the Silicon Valley tech industry. Yahoo
doesn't need to lurch south toward Hollywood again--this is what
got it in trouble last time. Yahoo needs to refresh its Valley
roots, by once again becoming a hotbed of top-notch engineering
talent. Facebook would be a better match (but Yahoo already
passed on Facebook).

Rupert Murdoch is no dummy--and he's selling MySpace at a
good time. MySpace has lost a lot of ground over the
past year, and we suspect this competitive erosion will continue.
Rupert Murdoch has been hailed as a genius for picking MySpace up
for a song. Yahoo investors should consider the possibility that
he's displaying similar acumen now.

Jerry Yang is no dummy, either, but he's
desperate. According to the WSJ, previous Yahoo-MySpace
deal discussions have fallen apart based on price (thank
goodness). At a $6-$10 billion reported valuation for MySpace, we
suspect they should again fall apart based on price. We're
worried, however, that Jerry is so eager to save his baby
(Yahoo), that he'll embrace a deal he shouldn't.

Conclusion

There is a price at which a Yahoo acquisition of MySpace would
make sense, but $6-$10 billion probably isn't it. So this leaves
the cash piece of the deal.

If News Corp and the Mysterious Private Equity Firm (Quadrangle?)
buy $5-$9 billion of newly issued stock from Yahoo at, say, $30 a
share, then that might be interesting. Yahoo's current
shareholders would at least be benefitting from the price boost
of Microsoft's offer, and the company would emerge far better
capitalized, with a $10 billion war chest.

But something tells us Rupert and the Mysterious Private Equity
Firm aren't going to rush to buy $5-$9 billion worth of stock at
$30 that they could have had two weeks ago for $19. And we're
especially skeptical that they're going to pay $35 for it, once
Microsoft raises its bid.

So we think a News Corp-Yahoo deal is unlikely to happen and
unlikely to sway Yahoo shareholders, who are now fixated on a $35
Microsoft deal.